Trump’s Tariff Shock: FX Markets on Edge.

• Trump’s Tariff Shock: The U.S. unexpectedly imposes immediate tariffs on Mexico and Canada, abandoning a negotiation window, signaling a shift toward a high-tariff, low-tax economy.
• Market Reaction: The dollar rallies as the DXY jumps 1%, while commodity currencies (AUD, NZD) fall hardest. Safe-havens (JPY, CHF) outperform, and U.S. equities drop 2%.
• Yield Curve Impact: Flattening U.S. yield curve suggests reduced Fed easing expectations and increased recession risks, further strengthening the dollar.
• EUR Weakness: Rising trade war risks and ECB easing expectations push EUR/USD to a cycle low of 1.0140, with further downside expected.
• GBP Resilience: Sterling holds up better due to the UK’s trade deficit with the U.S., but the upcoming Bank of England meeting could introduce downside risks for GBP/USD.

USD: Trump Delivers a Surprise Punch
Saturday’s unexpected announcement that the U.S. will impose full tariffs on Mexico and Canada starting tomorrow has jolted FX markets. Just a day prior, reports suggested tariffs would take effect on March 1, seemingly allowing a negotiation window. However, the Trump administration’s ‘maximum pressure’ tactic has opted for immediate action, likely aiming for a swift deal. The challenge for investors is that no clear path exists to avoid these tariffs. Trump has indicated there’s ‘nothing they can do,’ signaling a structural shift towards a high-tariff, low-tax U.S. economy. A key Commerce Department report due in April, investigating the country’s persistent trade deficits, could pave the way for universal tariffs.

Markets reacted defensively, with the dollar rallying as the DXY index jumped by 1%. Commodity-linked currencies, particularly the Australian and New Zealand dollars, took the biggest hit, even more than the Canadian dollar. Meanwhile, safe-haven currencies like the Japanese yen and Swiss franc outperformed. S&P futures fell 2%, pressured by concerns over disrupted supply chains and weaker corporate profits. A flattening U.S. yield curve has also emerged, with investors pricing in fewer Fed rate cuts due to the inflationary effects of tariffs, and 10-year yields dropping on increased recession risks. This yield curve dynamic supports the dollar while weighing on growth-sensitive currencies. For context, the Bank of Canada’s analysis of 25% tariffs on Canadian growth and inflation is worth reviewing.

What’s Next?
Investors will closely watch for any last-minute diplomatic efforts between Trump and his Canadian and Mexican counterparts. However, expectations are low for a resolution in 24 hours. FX traders will shift their focus to equity market reactions—if U.S. stocks fall enough to force a more dovish Fed stance, the Japanese yen could strengthen further, even against the dollar. Commodity-linked currencies remain vulnerable. Additionally, attention will turn to U.S. automakers, which could see significant market movements.

Macroeconomic data may take a backseat this week, but key reports include today’s ISM manufacturing confidence index and Friday’s January jobs data. The latter could be skewed by benchmark revisions, potentially lowering prior job creation figures and posing a downside risk to the dollar.

Unless Trump unexpectedly reverses course (unlikely), expect the dollar to remain firm near its highs for the year. Friday’s data revision could be the best shot at closing the overnight DXY gap down to 108.56.

EUR: Facing a Headwind
The rising threat of a global trade war, with potential tariffs targeting the EU, is a clear negative for the euro. The two-year EUR/USD rate differentials have widened by roughly 20 basis points, reflecting expectations of less Fed easing and more ECB easing. This has pushed EUR/USD to a new cycle low of 1.0140. While there’s an upside gap to 1.0350, it will only close if North America finds common ground today or if stock market turmoil forces widespread unwinding of dollar-long positions.

Firm rhetoric from European leaders unwilling to bow to U.S. pressure is likely to weigh further on the euro. Additionally, the April trade report, which may justify broad U.S. tariffs, keeps the market in a sell-on-rally mindset for EUR/USD.

GBP: A Temporary Reprieve
The British pound has been relatively resilient compared to other G10 currencies, likely because the UK runs a trade deficit with the U.S. and its goods exports make up a smaller share of GDP. This has put pressure on EUR/GBP today. However, Thursday’s Bank of England meeting poses downside risks for sterling. Given the broadly bullish dollar environment, any weakness is more likely to show in GBP/USD than EUR/GBP. A move towards 1.2200, or even 1.2100, is plausible this week, depending on further U.S. trade developments.